‘Wealth Effect’ Driven More by Homes Than Stocks

One of the big questions hovering over the market highs is the 'wealth effect.'

Normally when markets hit record highs, Americans feel wealthier because of their bursting portfolios. That paper wealth creates more confidence, which creates more spending, at least according to the theory of the wealth effect.

This time, however, the wealth effect seems more muted. Markets have been surging since 2009, and yet the added $10 trillion in market wealth hasn't done much for spending or jobs.

The reason might lie in the different wealth effects for housing and stocks.

According to new research from Capital Economics, total household wealth in America rose $4.8 trillion, to $65.1 trillion – close to its pre-crisis high. So in pure dollar terms, Americans are nearly as wealthy as they were before the crisis.

But much of last year's gain was from stock-market wealth, which tends to benefit the wealthy and affluent more than the broader population. Of the $4.8 trillion in added wealth, $3.6 trillion was from equity values. Housing prices also increased, but the gains were far more modest, adding $1 trillion to wealth.

But if housing continues to strengthen, the wealth effect may become far more powerful. According to research cited by Capital Economics, each one-dollar gain in wealth from housing creates 10 cents in spending. That's far more than the two cents in spending generated by every dollar of stock-market wealth.

Capital Economics says that if housing prices rise by five percent and the S&P stays near 1,500, the added wealth could add 0.7 percent to the GDP. That would more than offset the projected half-percent impact from the sequester budget cuts.

"Our growth forecasts will need to be changed only if asset prices rise by much more or fall significantly," according to Capital Economics.

At the moment, those changes appear more likely to be higher than lower.